A Lost & New Decade, Part I

January 29, 2010

A Lost New Decade Part I Fig9


Recant the above nevers (existing all at the same time) when viewing the strong recoveries that followed past depressions/recessions, and know that “it is truly different this time.”

Too Big To Be Downgraded

In 2010, we will reprice British (United Kingdom,
) & Japanese (JPY) sovereign default risk. A contagious repricing of this risk for developed nations will then ensue. Rates would go higher in the U.S. if the
and JPY government bonds begin to command higher-yield premiums for higher default risk. These added premiums will go higher than the actual risks. Another factor that will raise risk premium is
's conversion from domestically funded fiscal deficits to deficits that need funding with some external debt. The
also might have to raise external funds to fund their 2010 deficit.

The U.K., like the
, will delay rate hikes and fiscal discipline and revamp QE programs if needed to stimulate their economies in their respective election years. They saw what happened in the recent Japanese election, where the old guard was thrown out in favor of officials who will implement more populist fiscal spending.

U.K. & JPY will be competing with
domestic TSY debt offerings that are near $2.6t in 2010. These factors strengthen the case for much higher TSY yields in 2010. More U.S. dollar ($USD) debasement is forthcoming, leading to stagflation, with inflation near 3 to 4 percent and RGDP near 2 percent by late 2010 to early 2011.

Too big to be downgraded—that is the status for U.S., but it is one that might end in 2010 for the
or JPY. Global $USD reserves were 72 percent in 2006 and are now near 62 percent without foreign exchange adjustments. Historically, the range has been 60 to 70 percent. U.S. ratings downgrades might start when $USD reserves near 55 percent (sources: Barclays Capital, U.S. Interest Rates Outlook 2010 and Roubini Global Economics) stemming from declines in $USD and diversification of foreign reserve holdings out of the $USD into other assets such as
’s gold purchase near $1040 a troy ounce in November 2009. If the U.S. were no longer too big to be downgraded, then U.S. banks would no longer be too big to fail (TBTF), and subsequently foreigners and hedge funds would have more reason to sell their
stocks and bonds. London Interbank Offered Rate (Libor) would soar due to the implied financial system risk.

In 2010, the move will be out of bills and into 6- to 7-year TSY bonds. Wall Street expects MBS rates to climb 30 to 50 basis points, after which they expect investors to buy them off the FRB. I do not think so. If not, the FRB will simply ship them to Fannie Mae, the primary mortgage government-sponsored enterprise (GSE).


John Serrapere works on research and consulting projects through Arrow Insights. He welcomes comments and suggestions for future columns at

[email protected]

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